14 Long-Term Liabilities



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  • Prepared by
  • Coby Harmon
  • University of California, Santa Barbara
  • Intermediate Accounting
  • Intermediate Accounting
  • 14th Edition
  • 14
  • Long-Term Liabilities
  • Kieso, Weygandt, and Warfield

Learning Objectives

  • Describe the formal procedures associated with issuing long-term debt.
  • Identify various types of bond issues.
  • Describe the accounting valuation for bonds at date of issuance.
  • Apply the methods of bond discount and premium amortization.
  • Describe the accounting for the extinguishment of non-current liabilities.
  • Explain the accounting for long-term notes payable.
  • Describe the accounting for the fair value option.
  • Explain the reporting of off-balance-sheet financing arrangements.
  • Indicate how to present and analyze long-term debt.

Long-Term Liabilities

  • Bonds Payable
  • Long-Term Notes Payable
  • Reporting and Analyzing Long-Term Debt
  • Issuing bonds
  • Types and ratings
  • Valuation
  • Effective-interest method
  • Costs of issuing
  • Extinguishment
  • Notes issued at face value
  • Notes not issued at face value
  • Special situations
  • Mortgage notes payable
  • Fair value option
  • Off-balance-sheet financing
  • Presentation and analysis

Bonds Payable

  • Long-term debt consist of probable future sacrifices of economic benefits arising from present obligations that are not payable within a year or the operating cycle of the company, whichever is longer.
  • LO 1 Describe the formal procedures associated with issuing long-term debt.
  • Examples:
  • Bonds payable
  • Long-term notes payable
  • Mortgages payable
  • Pension liabilities
  • Lease liabilities
  • Long-term debt has various covenants or restrictions.

Issuing Bonds

  • LO 1 Describe the formal procedures associated with issuing long-term debt.
  • Bond contract known as a bond indenture.
  • Represents a promise to pay:
    • sum of money at designated maturity date, plus
    • periodic interest at a specified rate on the maturity amount (face value).
  • Paper certificate, typically a $1,000 face value.
  • Interest payments usually made semiannually.
  • Used when the amount of capital needed is too large for one lender to supply.

Types and Ratings of Bonds

  • LO 2 Identify various types of bond issues.
  • Common types found in practice:
    • Secured and Unsecured (debenture) bonds.
    • Term, Serial, and Callable bonds.
    • Convertible, Commodity-Backed, Deep-Discount bonds.
    • Registered and Bearer (Coupon) bonds.
    • Income and Revenue bonds.

Types and Ratings of Bonds

  • LO 2 Identify various types of bond issues.
  • Corporate bond listing.
  • Company Name
  • Interest rate paid as a % of par value
  • Price as a % of par
  • Interest rate based on price

Valuation of Bonds Payable

  • LO 3 Describe the accounting valuation for bonds at date of issuance.
  • Issuance and marketing of bonds to the public:
    • Usually takes weeks or months.
    • Issuing company must
      • Arrange for underwriters.
      • Obtain SEC approval of the bond issue, undergo audits, and issue a prospectus.
      • Have bond certificates printed.

Valuation of Bonds Payable

  • LO 3 Describe the accounting valuation for bonds at date of issuance.
  • Selling price of a bond issue is set by the
    • supply and demand of buyers and sellers,
    • relative risk,
    • market conditions, and
    • state of the economy.
  • Investment community values a bond at the present value of its expected future cash flows, which consist of (1) interest and (2) principal.

Valuation of Bonds Payable

  • Interest Rate
    • Stated, coupon, or nominal rate = Rate written in the terms of the bond indenture.
      • Bond issuer sets this rate.
      • Stated as a percentage of bond face value (par).
    • Market rate or effective yield = Rate that provides an acceptable return commensurate with the issuer’s risk.
      • Rate of interest actually earned by the bondholders.
  • LO 3 Describe the accounting valuation for bonds at date of issuance.

Valuation of Bonds Payable

  • How do you calculate the amount of interest that is actually paid to the bondholder each period?
  • How do you calculate the amount of interest that is actually recorded as interest expense by the issuer of the bonds?
  • LO 3 Describe the accounting valuation for bonds at date of issuance.
  • (Stated rate x Face Value of the bond)
  • (Market rate x Carrying Value of the bond)

Valuation of Bonds Payable

  • Bonds Sold At
  • 6%
  • 8%
  • 10%
  • Premium
  • Par Value
  • Discount
  • LO 3
  • Assume Stated Rate of 8%

Valuation of Bonds Payable

  • Illustration: ServiceMaster Company issues $100,000 in bonds, due in five years with 9 percent interest payable annually on January 1. At the time of issue, the market rate for such bonds is 11 percent.
  • LO 3 Describe the accounting valuation for bonds at date of issuance.
  • Illustration 14-1

Valuation of Bonds Payable

  • Illustration 14-1
  • LO 3 Describe the accounting valuation for bonds at date of issuance.
  • Illustration 14-2

Bonds Issued at Par on Interest Date

  • Illustration: Buchanan Company issues at par 10-year term bonds with a par value of $800,000, dated January 1, 2012, and bearing interest at an annual rate of 10 percent payable semiannually on January 1 and July 1, it records the following entry.
  • LO 3 Describe the accounting valuation for bonds at date of issuance.
  • Journal entry on date of issue, Jan. 1, 2012.
  • Cash 100,000
  • Bonds payable 100,000

Bonds Issued at Par on Interest Date

  • Journal entry to record first semiannual interest payment on July 1, 2012.
  • Interest expense 40,000
  • Cash 40,000
  • Journal entry to accrue interest expense at Dec. 31, 2012.
  • Interest expense 40,000
  • Interest payable 40,000
  • ($800,000 x .10 x ½)
  • LO 3 Describe the accounting valuation for bonds at date of issuance.

Bonds Issued at a Discount on Interest Date

  • LO 3 Describe the accounting valuation for bonds at date of issuance.
  • Illustration: Now assume Buchanan Company issues at 97, 10-year term bonds with a par value of $800,000, dated January 1, 2012, and bearing interest at an annual rate of 10 percent payable semiannually on January 1 and July 1, it records the issuance as follows.
  • Cash ($800,000 x .97) 776,000
  • Discount on bonds payable 24,000
  • Bonds payable 800,000

Bonds Issued at a Discount on Interest Date

  • Interest expense 41,200
  • Discount on bonds payable 1,200
  • Cash 40,000
  • At Dec. 31, 2012, Buchanan makes the following adjusting entry.
  • LO 3
  • Illustration: Buchanan records the first semiannual interest payment and the bond discount on July 1, 2012 as follows. Buchanan amortizes the bond discount using the straight-line method.
  • Interest expense 41,200
  • Discount on bonds payable 1,200
  • Interest payable 40,000

Bonds Issued at a Premium on Interest Date

  • LO 3 Describe the accounting valuation for bonds at date of issuance.
  • Illustration: Now assume Buchanan Company issues at 103, 10-year term bonds with a par value of $800,000, dated January 1, 2012, and bearing interest at an annual rate of 10 percent payable semiannually on January 1 and July 1, it records the issuance as follows.
  • Cash ($800,000 x .103) 824,000
  • Premium on bonds payable 24,000
  • Bonds payable 800,000

Bonds Issued at a Premium on Interest Date

  • Interest expense 38,800
  • Premium on bonds payable 1,200
  • Cash 40,000
  • At Dec. 31, 2012, Buchanan makes the following adjusting entry.
  • LO 3
  • Illustration: Buchanan records the first semiannual interest payment and the bond discount on July 1, 2012 as follows. Buchanan amortizes the bond premium using the straight-line method.
  • Interest expense 38,800
  • Premium on bonds payable 1,200
  • Interest payable 40,000

Valuation of Bonds

  • Bond investors will pay the seller the interest accrued from the last interest payment date to the date of issue.
  • On the next semiannual interest payment date, bond investors will receive the full six months’ interest payment.
  • Bonds Issued between Interest Dates
  • LO 3 Describe the accounting valuation for bonds at date of issuance.

Bonds Issued between Interest Dates

  • Illustration: on March 1, 2012, Taft Corporation issues 10-year bonds, dated January 1, 2012, with a par value of $800,000. These bonds have an annual interest rate of 6 percent, payable semiannually on January 1 and July 1. Taft records the bond issuance at par plus accrued interest as follows.
  • LO 4 Apply the methods of bond discount and premium amortization.
  • Cash 808,000
  • Bonds payable 800,000
  • Interest expense ($800,000 x .06 x 2/12) 8,000

Bonds Issued between Interest Dates

  • On July 1, 2012, four months after the date of purchase, Taft pays the purchaser six months’ interest, by making the following entry.
  • Interest expense 24,000
  • Cash 24,000
  • LO 4 Apply the methods of bond discount and premium amortization.

Bonds Issued between Interest Dates

  • If, however, Taft issued the 6 percent bonds at 102, its March 1 entry would be:
  • Cash 824,000
  • Bonds Payable 800,000
  • Premium on Bonds Payable ($800,000 x .02) 16,000
  • Interest Expense 8,000
  • * [($800,000 x 1.02) + ($800,000 x .06 x 2/12)]
  • *
  • LO 4 Apply the methods of bond discount and premium amortization.

Effective-Interest Method

  • Effective-interest method produces a periodic interest expense equal to a constant percentage of the carrying value of the bonds.
  • LO 4 Apply the methods of bond discount and premium amortization.
  • Illustration 14-3

Effective-Interest Method

  • LO 4 Apply the methods of bond discount and premium amortization.
  • Illustration 14-4
  • Illustration: Evermaster Corporation issued $100,000 of 8% term bonds on January 1, 2012, due on January 1, 2017, with interest payable each July 1 and January 1. Investors require an effective-interest rate of 10%. Calculate the bond proceeds.

Effective-Interest Method

  • LO 4
  • Illustration 14-5

Effective-Interest Method

  • Journal entry on date of issue, Jan. 1, 2012.
  • Cash 92,278
  • Discount on bonds payable 7,722
  • Bonds payable 100,000
  • Illustration 14-5
  • LO 4 Apply the methods of bond discount and premium amortization.

Effective-Interest Method

  • LO 4
  • Interest expense 4,614
  • Discount on bonds payable 614
  • Cash 4,000
  • Journal entry to record first payment and amortization of the discount on July 1, 2012.
  • Illustration 14-5

Effective-Interest Method

  • LO 4
  • Journal entry to record accrued interest and amortization of the discount on Dec. 31, 2012.
  • Interest expense 4,645
  • Interest payable 4,000
  • Discount on bonds payable 645
  • Illustration 14-5

Effective-Interest Method

  • Illustration: Evermaster Corporation issued $100,000 of 8% term bonds on January 1, 2012, due on January 1, 2017, with interest payable each July 1 and January 1. Investors require an effective-interest rate of 6%. Calculate the bond proceeds.
  • LO 4 Apply the methods of bond discount and premium amortization.
  • Bonds Issued at a Premium
  • Illustration 14-6

Effective-Interest Method

  • LO 4
  • Illustration 14-7

Effective-Interest Method

  • Journal entry on date of issue, Jan. 1, 2012.
  • Cash 108,530
  • Premium on bonds payable 8,530
  • Bonds payable 100,000
  • Illustration 14-7
  • LO 4 Apply the methods of bond discount and premium amortization.

Effective-Interest Method

  • LO 4
  • Interest expense 3,256
  • Premium on bonds payable 744
  • Cash 4,000
  • Journal entry to record first payment and amortization of the premium on July 1, 2012.
  • Illustration 14-7

Effective-Interest Method

  • What happens if Evermaster prepares financial statements at the end of February 2012? In this case, the company prorates the premium by the appropriate number of months to arrive at the proper interest expense, as follows.
  • LO 4 Apply the methods of bond discount and premium amortization.
  • Accrued Interest
  • Illustration 14-8

Effective-Interest Method

  • Evermaster records this accrual as follows.
  • LO 4 Apply the methods of bond discount and premium amortization.
  • Accrued Interest
  • Interest expense 1,085.33
  • Premium on bonds payable 248.00
  • Interest payable 1,333.33
  • Illustration 14-8

Effective-Interest Method

  • Companies report bond discounts and bond premiums as a direct deduction from or addition to the face amount of the bond.
  • LO 4 Apply the methods of bond discount and premium amortization.
  • Classification of Discount and Premium

Effective-Interest Method

  • Unamortized bond issue costs are treated as a deferred charge and amortized over the life of the debt.
  • LO 4 Apply the methods of bond discount and premium amortization.
  • Cost of Issuing Bonds
  • Illustration: Microchip Corporation sold $20,000,000 of 10-year debenture bonds for $20,795,000 on January 1, 2012 (also the date of the bonds). Costs of issuing the bonds were $245,000. Microchip records the issuance of the bonds and amortization of the bond issue costs as follows.

Effective-Interest Method

  • Jan. 1, 2012
  • LO 4 Apply the methods of bond discount and premium amortization.
  • Cash 20,550,000
  • Unamortized bond issue costs 245,000
  • Premium on bonds payable 795,000
  • Bonds payable 20,000,000
  • Illustration: Microchip Corporation sold $20,000,000 of 10-year debenture bonds for $20,795,000 on January 1, 2012 (also the date of the bonds). Costs of issuing the bonds were $245,000.
  • Dec. 1, 2012
  • Bond issue expense 24,500
  • Unamortized bond issue costs 24,500

Extinguishment of Debt

  • Illustration: On January 1, 2005, General Bell Corp. issued at 97 bonds with a par value of $800,000, due in 20 years. It incurred bond issue costs totaling $16,000. Eight years after the issue date, General Bell calls the entire issue at 101 and cancels it. General Bell computes the loss on redemption (extinguishment).
  • Illustration 14-10
  • LO 5 Describe the accounting for the extinguishment of debt.

Extinguishment of Debt

  • Bonds payable 800,000
  • Loss on redemption of bonds 32,000
  • Discount on bonds payable 14,400
  • Unamortized bond issue costs 9,600
  • Cash 808,000
  • General Bell records the reacquisition and cancellation of the bonds as follows:
  • LO 5 Describe the accounting for the extinguishment of debt.

Long-Term Notes Payable

  • Accounting is Similar to Bonds
    • A note is valued at the present value of its future interest and principal cash flows.
    • Company amortizes any discount or premium over the life of the note.
  • LO 6 Explain the accounting for long-term notes payable.

Notes Issued at Face Value

  • BE14-12: Coldwell, Inc. issued a $100,000, 4-year, 10% note at face value to Flint Hills Bank on January 1, 2013, and received $100,000 cash. The note requires annual interest payments each December 31. Prepare Coldwell’s journal entries to record (a) the issuance of the note and (b) the December 31 interest payment.
  • (a) Cash 100,000
  • Notes payable 100,000
  • (b) Interest expense 10,000
  • Cash 10,000
  • ($100,000 x 10% = $10,000)
  • LO 6 Explain the accounting for long-term notes payable.

Notes Not Issued at Face Value

  • Issuing company records the difference between the face amount and the present value (cash received) as
    • a discount and
    • amortizes that amount to interest expense over the life of the note.
  • LO 6 Explain the accounting for long-term notes payable.
  • Zero-Interest-Bearing Notes

Zero-Interest-Bearing Notes

  • BE14-13: Samson Corporation issued a 4-year, $75,000, zero-interest-bearing note to Brown Company on January 1, 2013, and received cash of $47,663. The implicit interest rate is 12%. Prepare Samson’s journal entries for (a) the Jan. 1 issuance and (b) the Dec. 31 recognition of interest.
  • LO 6

Zero-Interest-Bearing Notes

  • LO 6 Explain the accounting for long-term notes payable.
  • BE14-13: Samson Corporation issued a 4-year, $75,000, zero-interest-bearing note to Brown Company on January 1, 2013, and received cash of $47,663. The implicit interest rate is 12%. Prepare Samson’s journal entries for (a) the Jan. 1 issuance and (b) the Dec. 31 recognition of interest.
  • Cash 47,664
  • Discount on Notes Payable 27,336
  • Notes Payable 75,000
  • (a)
  • Interest expense 5,720
  • Discount on Notes Payable 5,720
  • (b)

Interest-Bearing Notes

  • BE14-14: McCormick Corporation issued a 4-year, $40,000, 5% note to Greenbush Company on Jan. 1, 2013, and received a computer that normally sells for $31,495. The note requires annual interest payments each Dec. 31. The market rate of interest is 12%. Prepare McCormick’s journal entries for (a) the Jan. 1 issuance and (b) the Dec. 31 interest.
  • LO 6

Interest-Bearing Notes

  • (a) Computer 31,495
  • Discount on notes payable 8,505
  • Notes payable 40,000
  • Interest expense 3,779
  • Cash 2,000
  • Discount on notes payable 1,779

Special Notes Payable Situations

  • LO 6 Explain the accounting for long-term notes payable.
  • No interest rate is stated, or
  • The stated interest rate is unreasonable, or
  • The face amount is materially different from the current cash price for the same or similar items or from the current fair value of the debt instrument.
  • When exchanging the debt instrument for property, goods, or services in a bargained transaction, the stated interest rate is presumed to be fair unless:

Special Notes Payable Situations

  • If a company cannot determine the fair value of the property, goods, services, or other rights, and if the note has no ready market, the company must approximate an applicable interest rate.
  • LO 6 Explain the accounting for long-term notes payable.
  • Choice of rate is affected by:
    • Prevailing rates for similar instruments.
    • Factors such as restrictive covenants, collateral, payment schedule, and the existing prime interest rate.
  • Choice of Interest Rates

Special Notes Payable Situations

  • LO 6 Explain the accounting for long-term notes payable.
  • Illustration: On December 31, 2012, Wunderlich Company issued a promissory note to Brown Interiors Company for architectural services. The note has a face value of $550,000, a due date of December 31, 2017, and bears a stated interest rate of 2 percent, payable at the end of each year. Wunderlich cannot readily determine the fair value of the architectural services, nor is the note readily marketable. On the basis of Wunderlich’s credit rating, the absence of collateral, the prime interest rate at that date, and the prevailing interest on Wunderlich’s other outstanding debt, the company imputes an 8 percent interest rate as appropriate in this circumstance.

Special Notes Payable Situations

  • LO 6 Explain the accounting for long-term notes payable.
  • Illustration 14-15
  • Illustration 14-16

Special Notes Payable Situations

  • LO 6 Explain the accounting for long-term notes payable.
  • Wunderlich records issuance of the note on Dec. 31, 2012, in payment for the architectural services as follows.
  • Building (or Construction in Process) 418,239
  • Discount on notes payable 131,761
  • Notes Payable 550,000

Special Notes Payable Situations

  • LO 6 Explain the accounting for long-term notes payable.
  • Illustration 14-20
  • Payment of first year’s interest and amortization of the discount.
  • Interest expense 33,459
  • Discount on notes payable 22,459
  • Cash 11,000

Mortgage Notes Payable

  • A promissory note secured by a document called a mortgage that pledges title to property as security for the loan.
  • LO 6 Explain the accounting for long-term notes payable.
    • Most common form of long-term notes payable.
    • Payable in full at maturity or in installments.
    • Fixed-rate mortgage.
    • Variable-rate mortgages.

Fair Value Option

  • LO 7 Describe the accounting for the fair value option.
  • Companies have the option to record fair value in their accounts for most financial assets and liabilities, including bonds and notes payable.
  • The FASB believes that fair value measurement for financial instruments, including financial liabilities, provides more relevant and understandable information than amortized cost.

Fair Value Option

  • LO 7 Describe the accounting for the fair value option.
  • Non-current liabilities are recorded at fair value, with unrealized holding gains or losses reported as part of net income.
  • Fair Value Measurement
  • Illustrations: Edmonds Company has issued $500,000 of 6 percent bonds at face value on May 1, 2012. Edmonds chooses the fair value option for these bonds. At December 31, 2012, the value of the bonds is now $480,000 because interest rates in the market have increased to 8 percent.
  • Bonds Payable 20,000
  • Unrealized Holding Gain or Loss—Income 20,000

Off-Balance-Sheet Financing

  • Off-balance-sheet financing is an attempt to borrow monies in such a way to prevent recording the obligations.
  • LO 8 Explain the reporting of off-balance-sheet financing arrangements.
  • Different Forms:
    • Non-Consolidated Subsidiary
    • Special Purpose Entity (SPE)
    • Operating Leases

Presentation and Analysis

  • Note disclosures generally indicate the nature of the liabilities, maturity dates, interest rates, call provisions, conversion privileges, restrictions imposed by the creditors, and assets designated or pledged as security.
  • Fair value of the debt should be discloses.
  • Must disclose future payments for sinking fund requirements and maturity amounts of long-term debt during each of the next five years.
  • LO 9 Indicate how to present and analyze long-term debt.

Presentation and Analysis

  • Analysis of Long-Term Debt
  • Two ratios that provide information about debt-paying ability and long-run solvency are:
  • Total debt
  • Total assets
  • Debt to total assets
  • =
  • The higher the percentage of debt to total assets, the greater the risk that the company may be unable to meet its maturing obligations.
  • 1.
  • LO 9 Indicate how to present and analyze long-term debt.

Presentation and Analysis

  • Analysis of Long-Term Debt
  • Two ratios that provide information about debt-paying ability and long-run solvency are:
  • Income before income taxes and interest expense
  • Interest expense
  • Times interest earned
  • =
  • Indicates the company’s ability to meet interest payments as they come due.
  • 2.
  • LO 9 Indicate how to present and analyze long-term debt.

Presentation and Analysis

  • LO 9 Indicate how to present and analyze long-term debt.
  • Illustration: Best Buy has total liabilities of $11,338 million, total assets of $18,302 million, interest expense of $94 million, income taxes of $802 million, and net income of $1,317 million. We compute Best Buy’s debt to total assets and times interest earned ratios
  • Illustration 14-21
  • Usual Progression in Troubled-Debt Situations
  • Illustration 14A-1
  • A troubled-debt restructuring involves one of two basic types of transactions:
  • 1. Settlement of debt at less than its carrying amount.
  • 2. Continuation of debt with a modification of terms.
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Settlement of Debt
  • Can involve either a
    • transfer of noncash assets (real estate, receivables, or other assets) or
    • the issuance of the debtor’s stock.
  • Creditor should account for the noncash assets or equity interest received at their fair value.
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Illustration (Transfer of Assets): American City Bank loaned $20,000,000 to Union Mortgage Company. Union Mortgage cannot meet its loan obligations. American City Bank agrees to accept from Union Mortgage real estate with a fair value of $16,000,000 in full settlement of the $20,000,000 loan obligation. The real estate has a carrying value of $21,000,000 on the books of Union Mortgage. American City Bank (creditor) records this transaction as follows.
  • Land 16,000,000
  • Allowance for Doubtful Accounts 4,000,000
  • Note Receivable from Union Mortgage 20,000,000
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Illustration (Transfer of Assets): The bank records the real estate at fair value. Further, it makes a charge to the Allowance
  • for Doubtful Accounts to reflect the bad debt write-off.
  • Union Mortgage (debtor) records this transaction as follows.
  • Note Payable to American City Bank 20,000,000
  • Loss on Disposal of Land 5,000,000
  • Land 21,000,000
  • Gain on Restructuring of Debt 4,000,000
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Illustration (Granting an Equity Interest): American City Bank agrees to accept from Union Mortgage 320,000 shares of common stock ($10 par) that has a fair value of $16,000,000, in full settlement of the $20,000,000 loan obligation. American City Bank (creditor) records this transaction as follows.
  • Investment 16,000,000
  • Allowance for Doubtful Accounts 4,000,000
  • Note Receivable from Union Mortgage 20,000,000
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Illustration (Granting an Equity Interest): It records the stock as an investment at the fair value at the date of restructure.
  • Union Mortgage (debtor) records this transaction as follows.
  • Note Payable to American City Bank 20,000,000
  • Common Stock 3,200,000
  • Additional Paid-in Capital 12,800,000
  • Gain on Restructuring of Debt 4,000,000
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Modification of Terms
  • A debtor’s serious short-run cash flow problems will lead it to request one or a combination of the following modifications:
    • Reduction of the stated interest rate.
    • Extension of the maturity date of the face amount of the debt.
    • Reduction of the face amount of the debt.
    • Reduction or deferral of any accrued interest.
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Illustration (Example 1—No Gain for Debtor): On December 31, 2011, Morgan National Bank enters into a debt restructuring agreement with Resorts Development Company, which is experiencing financial difficulties. The bank restructures a $10,500,000 loan receivable issued at par (interest paid to date) by:
    • Reducing the principal obligation from $10,500,000 to $9,000,000;
    • Extending the maturity date from December 31, 2011, to December 31, 2015; and
    • Reducing the interest rate from 12% to 8%.
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Schedule Showing Reduction of Carrying Amount of Note
  • Illustration 14A-2
  • Notes Payable 356,056
  • Interest Expense 363,944
  • Cash 720,000
  • Dec. 31, 2012
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Schedule Showing Reduction of Carrying Amount of Note
  • Notes Payable 9,000,000
  • Cash 9,000,000
  • Dec. 31, 2015
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Illustration 14A-2
  • Illustration 14A-3
  • Morgan National Bank (creditor)
  • Morgan National Bank records bad debt expense as follows
  • Bad Debt Expense 2,593,428
  • Allowance for Doubtful Accounts 2,593,428
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Creditor Calculations
  • Illustration 14A-4
  • In subsequent periods, Morgan National Bank reports interest revenue based on the historical effective rate.
  • Cash 720,000
  • Allowance for Doubtful Accounts 228,789
  • Interest Revenue 948,789
  • Dec. 10, 2012
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Creditor Calculations
  • The creditor makes a similar entry (except for different amounts debited to Allowance for Doubtful Accounts and credited to Interest Revenue) each year until maturity. At
  • maturity, the company makes the following entry.
  • Cash 9,000,000
  • Allowance for Doubtful Accounts 1,500,000
  • Notes receivable 10,500,000
  • Dec. 10, 2015
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Illustration (Example 2—Gain for Debtor): Assume the facts in the previous example except that Morgan National Bank reduces the principal to $7,000,000 (and extends the maturity date to December 31, 2015, and reduces the interest from 12% to 8%). The total future cash flow is now $9,240,000 ($7,000,000 of principal plus $2,240,000 of interest), which is $1,260,000 ($10,500,000 $9,240,000) less than the pre-restructure carrying amount of $10,500,000. Under these circumstances, Resorts Development (debtor) reduces the carrying amount of its payable $1,260,000 and records a gain of $1,260,000. On the other hand, Morgan National Bank (creditor) debits its Bad Debt Expense for $4,350,444.
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Illustration (Example 2—Gain for Debtor): Morgan National Bank (creditor) debits its Bad Debt Expense for $4,350,444.
  • Illustration 14A-5
  • Illustration 14A-6
  • LO 10
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Illustration (Example 2—Gain for Debtor): Morgan National reports interest revenue the same as the previous example—
  • Illustration 14A-7
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • Illustration (Example 2—Gain for Debtor): Accounting for periodic interest payments and final principal payment.
  • Illustration 14A-8
  • LO 10 Describe the accounting for a debt restructuring.
  • APPENDIX 14A
  • TROUBLED-DEBT RESTRUCTURINGS
  • RELEVANT FACTS
    • Under GAAP, companies are permitted to use the straight-line method of amortization for bond discount or premium, provided that the amount recorded is not materially different than that resulting from effective-interest amortization. However, the effective-interest method is preferred and is generally used. Under IFRS, companies must use the effective-interest method.
    • Under IFRS, companies do not use premium or discount accounts but instead show the bond at its net amount. For example, if a $100,000 bond was issued at 97, under IFRS a company would record:
    • Cash 97,000
    • Bonds Payable 97,000
  • RELEVANT FACTS
    • Under GAAP, bond issue costs are recorded as an asset. Under IFRS, bond issue costs are netted against the carrying amount of the bonds.
    • GAAP uses the term troubled-debt restructurings and has developed specific guidelines related to that category of loans. IFRS generally assumes that all restructurings will be accounted for as extinguishments of debt.
  • Under IFRS, bond issuance costs, including the printing costs and legal fees associated with the issuance, should be:
    • expensed in the period when the debt is issued.
    • recorded as a reduction in the carrying value of bonds payable.
    • accumulated in a deferred charges account and amortized over the life of the bonds.
    • reported as an expenses in the period the bonds mature or are retired.
  • IFRS SELF-TEST QUESTION
  • Which of the following is stated correctly?
    • Current liabilities follow non-current liabilities on the statement of financial position under GAAP but follow current liabilities under IFRS.
    • IFRS does not treat debt modifications as extinguishments of debt.
    • Bond issuance costs are recorded as a reduction of the carrying value of the debt under GAAP but are recorded as an asset and amortized to expense over the term of the debt under IFRS.
    • Under GAAP, bonds payable is recorded at the face amount and any premium or discount is recorded in a separate account. Under IFRS, bonds payable is recorded at the carrying value so no separate premium or discount accounts are used.
  • IFRS SELF-TEST QUESTION

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